Inflation falls to 2.2% in Europe, clearing the way for ECB rate cut

Inflation in the 20 European Union countries that use the euro fell sharply to 2.2% in August, opening the door for the European Central Bank to cut interest rates as the ECB and the US Federal Reserve prepare to lower borrowing costs to support growth and jobs.

The August figure was down from 2.6% in July, according to figures on Friday from European Union statistics agency Eurostat.

Energy prices fell in August by 3%, helping lower the overall figure, while inflation fell to 2% in Germany, the eurozone’s largest economy.

The monthly figure is now close to the ECB’s target of 2%, the level considered best for the economy.

The central bank is charged with maintaining stable prices under the treaty that set up the European Union. Not all of the EU’s 27 countries use the euro.

Economists expect the ECB to cut its key rate by a quarter point from 3.75% at its September 12 meeting, while the Fed is expected to cut rates from a 23-year high of 5.25%-5.5% at its September 17-18 policy meeting.

The lower German inflation figure “tilts the balance toward a September rate cut”, said Carsten Brzeski, global chief of macro at ING bank.

“Fading inflationary pressure combined with fading growth momentum offer an almost perfect macro backdrop for another rate cut.”

Economists caution that the path downward to 2% may yet be a bumpy one. The ECB has said it expects inflation to fluctuate going forward but to fall to its target by the end of next year.

Central banks sharply raised interest rates to counter an outburst of inflation caused by a spike in energy prices after Russia’s invasion of Ukraine, and by clogged supply chains for parts and raw materials as the global economy bounced back from the Covid-19 pandemic.

Higher rates can quell inflation by making it more expensive to borrow and buy things, reducing demand for goods and thus taking pressure off prices.

Europe’s inflation has now fallen a long way from the 10.6% it reached in October 2022.

But higher rates can weigh on growth as well, and those concerns have come to the fore in both Europe and the US.

While unemployment rates remain low in both economies, central bankers are becoming wary of keeping rates too high for too long and seeing people lose their jobs or the economy tip into recession.

It is a tricky balance since the impact of rate moves comes only with a delay of months.

The eurozone grew only a modest 0.3% in the second quarter. High rates have killed off a years-long rally in European house prices and dampened loans to consumers and businesses, while complicating financing decisions for new renewable energy projects that are highly rate-sensitive.

Rates that “are too high for too long” would fail to minimise the side effects on economy activity and jobs, which in turn could lead to “chronically below-target inflation”, Philip Lane, a member of the ECB’s six-member executive board that runs the central bank day to day at its Frankfurt headquarters, said on Saturday.

Mr Lane kept the ECB’s options for September open however by saying that a return to the 2% target “is not yet secure”.

ECB head Christine Lagarde has said the bank will decide rates based on incoming data about the economy at the time.

The ECB made a first rate cut in June, then hit pause in July and has since been waiting for confirmation that the coast is clear to make more cuts.